If you make frequent trades in your TFSA, you might face a bigger-than-expected tax bill.

“CRA is taking a very aggressive position, in some cases, that some extensive trading in a TFSA could lead to the TFSA carrying on a business,” warns Jamie Golombek, managing director of tax and estate planning with CIBC Wealth Strategies Group.

When a TFSA is deemed to be carrying on a business, any associated gains are taxable as income, negating the TFSA’s tax-sheltering abilities.

Golombek says the following factors could determine whether someone is deemed to be carrying on a business in their account:

Trading frequency. Trading once a year or once a month won’t raise suspicion, says Golombek, but more frequent trading might. “There’s no bright-line test,” he explains. “The question is: Does the frequency of transactions trigger a red flag?”

Duration of holdings. “We don’t know exactly how long is [considered] too short” by CRA when it comes to holding stocks, says Golombek. What concerns CRA is when an ostensibly long-term investor buys blue-chip, dividend-paying stocks but sells mere days later.

Intentions for resale. CRA will try to determine whether you’re acquiring the securities to resell them at a profit or holding them for long-term growth and dividend income.

Nature and quantity of securities. The tipoff for CRA could be someone buying and selling the same names over and over again, in large amounts, says Golombek.

Time spent buying and selling. Not having a day job outside trading could blur the problem, he warns. “The concern here — not just for TFSAs but in general — is does it make sense that you’re earning most of your income from the securities business?”

In general, each time you dispose of a security, the gain on that security could be considered a capital gain, of which only 50% is taxable, or an income gain, of which 100% is taxable.

“Income versus capital is one of the most complex issues in tax law,” says Golombek. The issue has numerous interpretations in case law.

A case to consider

Golombek points to the 2017 case of a taxpayer who faced a CRA reassessment (Foote v The Queen, 2017 TCC 61). The taxpayer was a CFA who had 25 years’ experience in financial services and was head of institutional trading at a Canadian investment firm. He was also licensed as a trader and dealer.

In late 2009, he bought and sold stocks in two investment accounts from 34 different issuers, spending more than $2 million, says Golombek, who adds that his total gain was $550,000, with an average hold period of 50 days and an average return of 30%.

“This was of course after the market meltdowns,” notes Golombek.

The court decision says he also “sold some securities short” in the two accounts and throughout the period in question, but those trades were not in dispute. That’s because the “gains and losses on short sales were reported by Mr. Foote on income account throughout.”

The judge noted that each case is independent on its own facts. From the facts in this case, the judge ascertained the taxpayer had crossed the line from investing to trading, ruling that the facts revealed the taxpayer’s intention was to do business rather than to invest for the longer term.

That distinction is a tax principle, says Golombek. “This all comes down to the issue of income versus capital in a non-registered account,” he says. “And then, of course, the rule in the TFSA says that if you’re doing frequent trading it could be a business” and, therefore, the income is taxable.

In the court decision, the judge made clear the taxpayer wasn’t singled out because his investments were in securities; the taxpayer was reassessed in part because his day job involved trading securities. The judge added that “an antique dealer, […] a vintage car collector, a real estate broker or an auctioneer in comparable circumstances could reasonably expect a similar result.”

The judge didn’t accept the taxpayer’s testimony that his trading activity “wasn’t really related to his day job,” says Golombek. In the decision, the judge wrote, “I […] do not accept that Mr. Foote’s expertise and experience did not extend to what he regarded as actual trading activities,” noting that Foote had supervised trades.

Advisors beware

For advisors who offer investment advice, says Golombek, “The risk is certainly higher for our own TFSA and trading accounts that, should we be engaged in these factors that CRA looked at, we could be subject to tax on full business income rather than profits taxed as 50% capital gain.”

Of course, there’s an easy way to avoid the problem.

“There’s no concern whatsoever for a buy-and-hold strategy, where you don’t have frequent trading and you have long-term hold periods — even if someone’s in the investment business,” Golombek suggests.

Interesting that the success of Mr. Foote’s trading caught the eye of the CRA and his TFSA was deemed a business. What would have occurred (all things being the same) if Mr. Foote’s trades been unsuccessful and caused capital losses. Would the CRA then have allowed him to write off these loses? Would the CRRA have notified him that they thought his TFSA was a business if he had loses? Food for thought.